Millionaire Teacher (11 page)

The stories of wealth enticed individual investors and fund management firms alike before the eventual collapse of the dot-com bubble.

Mutual fund companies rushed to create technology-based funds that they could sell. The job of fund companies, of course, isn't to make money for you or me. Their primary job is to make money for their companies' owners or shareholders.

There's a saying that “Wall Street will sell what Wall Street can sell.” In this case, newly introduced technology-stock mutual funds were first-class tickets on airplanes with near-empty fuel tanks. Passengers giggled with delight as they soared into the clouds . . . until the fuel ran out.

Sadly, there were plenty of regular middle-class folk who climbed aboard this soon-to-be-plunging craft. When the plane hurtled into the ground, many investors in technology funds and Internet stocks lost nearly everything they had invested.

Few players in the Internet stock fiasco escaped unscathed. You might imagine loads of people getting out on top, or near the top, but the hysterical era of easily quadrupling your money within a matter of months swept through amateur and professional investors alike. Nobody really knew where that “top” was going to be, so loads of people kept climbing into tech stocks.

I'd be lying if I claimed to avoid the tech sector's sirens. In 1999, I succumbed to buying shares in one of the technology stock darlings of the day, Nortel Networks <
www.nortel.com/
>.

It was silly of me to buy it, but watching my friends making bucket loads of easy money on Internet stocks while I sat on the sidelines was more than I could take. Swept up in the madness, it didn't matter that I didn't really know what the company did.

Eventually getting around to reading Nortel's annual report, I recognized that the company had been losing more and more money since 1996. But I didn't care. Sure, it made me nervous, but the stock price was rising and I didn't want to be left behind.

What was worse was that every year since 1996, the business was losing more and more money while its stock price was going in the opposite direction: up! I paid $83 a share. When that stock price rose to $118, I had made a 42 percent profit. Late getting onto the Nortel train, I couldn't believe the money I had made in such a short time. Recognizing a quick profit, I figured it would be wise to sell, which is exactly what I did at $118 a share. If only the story ended there. No sooner did I sell than the price rose to $124 a share.

Then I read an analyst's report suggesting that the share price was going to rise to $150 before the year was up. What was I doing, selling at $118?

Shortly after the stock price dipped to $120, and like a knucklehead, I bought back the shares I had previously sold. I was watching the dog, while ignoring the owner's
rigor mortis.

And that's when gravity hurtled the stock price down to $100 a share . . . then $80 a share . . . then $50 a share. Suddenly, people were noticing the smell.

I sold at $48, losing almost half of what I put into my investment. I got burned for buying a stock I never should have bought in the first place because—despite the meteoric rise in its stock price—the business itself hadn't made a dime in years.

But I was lucky. Today, those same shares are worth pennies.

Many of my friends never sold. It's a shameful reminder on a brokerage statement of what can happen when we mix greed and ignorance.

Taking Advantage of Fear and Greed

Buying a total stock market index fund needn't be boring. If you can be greedy when others are fearful and fearful when others are greedy, you can add a touch of nitrate to your investment portfolio. You don't need to follow investment news or follow the markets. You just need to utilize the safest component of your investment portfolio—your bonds.

The disastrous events of September 11, 2001 invoked tremendous fear in the American people when terrorists hijacked two airliners and flew them into New York's World Trade Center. After the twin towers collapsed, the stock markets were temporarily closed. Sadly, nearly 3,000 people were killed in the terrorist attack.

But long term, how would that affect American business profits? As catastrophic as the event had been, it wasn't likely to have a permanent affect on the number of Coca-Cola cans sold worldwide, or McDonald's hamburger sales <
www.mcdonalds.com/us/en/home.html
>, or Starbucks coffee sales <
www.starbucks.com
>, or Safeway's food sales <
www.safeway.com/IFL/Grocery/Home
>. Americans are resilient, and so are their businesses.

But when the stock markets reopened after the terrorist attack, the prices of U.S. businesses dropped.

Short term, most investors prove their irrationality

Many investors don't think about the stock market as a representation of something real—like true business earnings. Fear and greed rule the short-term irrationality of stock markets. But thinking about the market as a group of businesses, and not a squiggly line on a chart or a quote in the paper, can fertilize your wealth. When there's a disconnection between business profits and stock prices, you can easily take advantage of the circumstances. What happened in the stock markets after 9/11 was the antithesis of the boom times of the late 1990s. Stock prices fell like football-sized chunks of hail, but business earnings were hardly affected.

When the New York Stock Exchange reopened after the 9/11 attacks, it might as well have held up a giant neon sign: “Stocks on sale today!” The U.S. stock market opened 20 percent lower than its opening level the previous month. Scraping together every penny I could muster, I dumped money into the stock market like a crazed shopper at a “going out of business” sale. Speculators hate doing that because they're continually worried the markets will fall further. Real investors never think like that. They care more about what the markets will be doing in 20 years not next week. Worrying about the immediate future is letting the stock market lead you by the gonads.

Most people have a backward view of the markets

The Oracle of Omaha, Warren Buffett, laid out a quiz in his 1997 letter to Berkshire Hathaway <
www.berkshirehathaway.com
> shareholders. If you can honestly pass this quiz, you'll be on your way to doing well in the stock market. But most investors and most financial advisers would fail this little quiz, and that's one of the reasons most people are poor investors. As Buffett wrote:

If you plan to eat hamburgers throughout your life and are not a cattle producer, should you wish for higher or lower prices for beef? Likewise, if you are going to buy a car from time to time but are not an auto manufacturer, should you prefer higher or lower car prices? These questions, of course, answer themselves.

But now for the final exam: If you expect to be a net saver during the next five years, should you hope for a higher or lower stock market during that period?

Many investors get this one wrong. Even though they are going to be net buyers of stocks for many years to come, they are elated when stock prices rise and depressed when they fall. In effect, they rejoice because prices have risen for the ‘hamburgers' they will soon be buying.

This reaction makes no sense. Only those who will be sellers of equities [stock market investments] in the near future should be happy at seeing stocks rise. Prospective purchasers should much prefer sinking prices.
12

Think of the stock market as a grocery store filled with nonperishable items. When prices fall, it's a good idea to stock up on those products because the prices will inevitably rise again. If you like to buy canned beans and the store is selling them this week at a 20 percent discount, you have a choice. You can sit on your haunches and wonder whether they'll be even cheaper the following week, or you can stop being silly and just buy the beans. If the price drops further the following month, you can always buy more cans. But if you sit on your butt and miss out on the sale (because you're speculating that beans will get cheaper), well . . . you miss out on the sale.

A stock market drop is the same as a sale at your local supermarket. I'll show you how to take advantage of such opportunities.

Opportunities after Chaos

Where did I get the money to take advantage of the stock market's discounted level when the markets reopened after 9/11? I sold some of my bonds. It didn't take any kind of special judgment on my part. I just stuck to a mechanical strategy, which I'll explain further in Chapter 5.

Unfortunately, the money I invested in the U.S. stock market index in September 2001 went on to gain 15 percent over just a few months. By January 2011 (even after the financial crisis of 2008–2009), the value of my stock purchases in the autumn of 2001 was up more than 55 percent, including dividends. But that upset me. Yes, you read that right. I was upset to see my stock market investments rise.

After 9/11, I wanted the markets to stay down. I was hoping to keep buying into the stock markets for many years at a discounted rate. It's a bit like betting that a sleeping dog on a long leash is eventually going to have to get up and run to catch its sprinting owner. The longer the leash and the longer that dog sleeps, the more money I can put on the dog, which will eventually tear after its owner up the hill, pulling my wheelbarrow load of money behind it. Sadly for me, the stock market didn't sleep in its discounted state for long.

Of course, not everybody is going to be happy about a sinking or stagnating stock market. My apologies to retirees. If you're retired, there's no way you're going to want to see plummeting stock prices. You're no longer able to buy cheap stocks when you're not making a salary. And, you'll be regularly selling small pieces of your investments every year to cover living expenses.

Younger people who will be adding to their portfolios for at least five years or more need to celebrate when markets fall. I didn't think I would get another opportunity to benefit from irrational fear after September 2001. A plunging stock market is a special treat for a wage earner—one that doesn't come along every day. But another opportunity fell on my lap again between 2002 and 2003, (as shown in
Figure 4.2
) with the stock market eventually selling at a 40 percent discount from its 2001 high, after the U.S. announced it was going to war with Iraq.

Figure 4.2
U.S. Stocks Offered a Wonderful Sale

Source:
Yahoo! Finance historical price tables for Dow Jones Industrials

Was the average U.S. business going to make 40 percent less money? Were businesses like PepsiCo <
www.pepsico.com
>, Wal-Mart <
www.walmart.com
>, Exxon Mobil <
www.exxonmobil.com/Corporate
>, and Microsoft <
www.microsoft.com/en-us/default.aspx
> going to see a 40 percent drop in profits? Even at the time, it would have been really tough to find anyone who believed that. Yet U.S. businesses were trading at a 40 percent discount on the stock market. I was salivating, and hoping that the markets would stay down this time—for years if possible. I wanted to load up.

I didn't know how low the markets would fall, so I wasn't lucky enough to buy stock indexes at the very bottom of the market's plunge. But it didn't matter to me. Once the “20 percent off” flags were waving in my face, I was a chocoholic stowaway in Willy Wonka's factory. The stock market continued to fall as I continued to buy. If I could have taken an extra job to give me more money to take advantage of cheap stock prices, I probably would have done it. For some reason, most investors were doing what they typically do: They overreact when prices fall, sending stocks to mouthwatering levels, by selling when they should be buying. They become afraid of a discounted sale, hoping (and yes, this is a true representation of insanity) that they can soon pay higher prices for their stock market products. They miss the point of what stocks are. Stocks represent ownership in real businesses.

Again, I hoped that the stock markets would keep falling in 2003, or that they would stay low for a few years so I could gorge at the buffet.

It was not to be. I was disappointed as the U.S. stock market index began a long recovery from 2002–2003 until the end of 2007, rising more than 100 percent from its low point in just four years. Retirees would have been celebrating, but I was crying in my oatmeal. The big supermarket sale was over.

As the stock market roared ahead in 2007, I didn't put a penny in my stock indexes. I bought bond indexes instead. Following a general rule of thumb, I wanted my bond allocation to equal my age. For example, I was 37 years old and I wanted 35 to 40 percent of my portfolio to be comprised of bonds. But the rapidly rising stock market in 2007 was sending my stock indexes far higher than the allocation I set for them. As a result, my bonds represented far less than 35 percent of my total account, so I spent 2007 buying bonds—even selling some of my stock indexes to do it.